Bitcoins

Bitcoin’s credibility got a major boost yesterday when New York state’s Department of Financial Services (NYDFS) announced it would begin taking applications for regulated digital currency exchanges.

The move comes less than two months after a series of public hearings in which bitcoin leaders spoke before the state regulators outlining the potential economic benefit of embracing virtual currencies and the need for any future regulation to foster, rather than hamper, innovation. It also follows a series of international exchange failures that in all likelihood saw consumers lose hundreds of millions in exchange deposits.

A statement from NYDFS superintendent Benjamin Lawsky reads:

Firms may immediately submit formal proposals and applications to operate virtual currency exchanges in order to help expedite the process of putting in place greater oversight for this industry. Such proposals and applications represent the formal commencement of a regulatory process, and may be modified by the firm through discussions with NYDFS to help ensure that they include robust consumer, cyber security, and anti-money laundering protections.

As the epicenter of global finance, New York and more specifically Wall Street, are essential to bitcoin’s success. Currently there are no major bitcoin exchanges in the US, let alone in New York, because up until this point, entrepreneurs and investors have been handcuffed by an ambiguous regulatory environment. During the recent New York hearings (and those on Capitol Hill that preceded them), the bitcoin community implored regulators to make the US a global leader in bitcoin, rather than shunning it offshore where the economic impact would be lost and consumers would be more likely to face fraud.

It appears those pleas have been heard, as Lawsky said of the announcement, “The fact is that virtual currencies are unlikely to disappear entirely. As such, turning a blind eye and failing to put in place guardrails for virtual currency firms while consumers use that product is simply not a tenable strategy for regulators.”

Not all bitcoin entrepreneurs are pleased at the prospect of tighter regulations governing bitcoin, as such government oversight flies in the face of the anti-establishment, decentralized tenets on which bitcoin was created. Many have expressed fears that regulations could chill many of the best things about bitcoin, including its pseudo-anonymity and low barrier to entry. The alternative – aside from allowing any unscrupulous or inept entrepreneur to launch a bitcoin exchange and thus risking consumer financial safety – is banning bitcoin businesses entirely or heavily restricting their operations, something that has occurred to various degrees in China, Russia, India, Iceland, and elsewhere.

While this latest announcement suggests that New York (and the US at large) will not ban bitcoin it remains to be seen just how onerous the regulations will be. The state has begun accepting applications from exchanges, but has yet to release the final regulatory framework within which these businesses will need to operate, something that’s expected later this year. It’s likely that bitcoin businesses will face minimum capital reserve requirements, permissible investment guidelines, and requirements for keeping a public blockchain general ledger to thwart money laundering, tax evasion, and other nefarious uses.

In an earlier statement on the upcoming bitcoin regulations, Lawsky said, “Let’s be frank, a lot more money has been laundered through large banks than has been laundered through virtual currency.”

While the NYDFS is taking steps to enable bitcoin businesses, Wall Street’s independent regulatory body The Financial Industry Regulatory Authority (FINRA) has taken a more cautious posture, issuing an investor alert that calls bitcoin “more than a bit risky,” and cites volatility and hacking risk as principal concerns.

A number of bitcoin firms appear poised to apply for NYDFS’s so-called “bitlicense,” including SecondMarket which is reportedly in advanced negotiations with a number of Wall Street investment banks, hedge funds, and traders regarding the creation of an institutional bitcoin exchange. The move is expected to increase liquidity and reduce volatility in the bitcoin market, both of which remain obstacles to wider consumer and merchant adoption of the virtual currency.

With New York leading the way, it seems likely that other US states and the federal government will eventually follow suit creating concrete regulations around the operation of virtual currency businesses. It’s the first step in in what promises to be a lengthy process. Anything that brings bitcoin out of the shadows and encourages widespread adoption should be viewed as a positive.